Transaction banking once suffered a dull reputation, considered a sleepy suburb compared with the bright lights and big city of investment banking. But times have changed and, as the glamorous end of the business has become expensive and volatile, chief executives are hankering after steady returns and predictability.

Bank chiefs pin hopes on nuts and bolts

Transaction banking has been bathing in plaudits since the financial crisis. Samir Assaf, HSBC’s chief executive of global banking and markets, said last year that banks were calling it “the holy grail of the industry”. Olivier Khayat, deputy head of corporate and investment banking and interim head of global transaction banking at UniCredit, described it as “the spine of the bank”.

Mainstream transaction banking offers a variety of products, such as payments, cash management, trade finance and securities services. Oliver Wyman said that the transaction banking revenue pool reached $321bn during 2012, up from $320bn in 2011 and $269bn in 2010. It offers a reliable income stream, while investment banking profits have swung wildly due to volatile markets and incoming regulation.

In 2010, Citigroup’s transaction banking unit, one of the largest, posted net profits of $3.6bn, in 2011 $3.4bn, and in 2012 $3.5bn.

By comparison, net income from the firm’s securities and banking business, which houses trading and investment banking, posted more volatile net profits of $6.7bn, $3.9bn and $6.1bn over the same time period.

Deutsche Bank’s Global Transaction Banking unit is slightly more variable after taking a €534m hit due to litigation charges. But from 2010 to 2012, the business returned net profits before tax of €900m, €1bn, and €700m over the three years. Its trading and investment banking arm posted net profits of €5.3bn, €3.6bn and €2.9bn.

Axel Miller, partner at Oliver Wyman and a leader in the transaction banking practice at the consultants, said the business doesn’t see nearly as much volatility compared with capital markets.
“It swings maybe 10% to 15% in one direction or another based on GDP and trade growth as well as interest rate development,” he said.

“That’s pretty much it: the cost base is largely stable. You have a fixed high cost rate driven by the infrastructure investment and a relatively fixed compensation structure.”

Change ahead

It is also a “sticky” business, as clients historically have been reluctant to change providers too regularly because of the cost and complexity of putting systems in place.

This, however, could change, said Carole Berndt, head of global transaction services for Europe, the Middle East and Africa at Bank of America Merrill Lynch: “Technological developments are changing that and making it easier for a corporate to change provider in less tech-intensive ways than before.

“As an industry, we’ve done a lot to standardise and harmonise technology, making it technically easier for them to change the mechanics of their transaction business.”

Not only are the returns more stable in GTS, but unlike investment banking, the business is capital-lite. Deutsche Bank, one of the few banks that has clear, transparent quarterly reporting, reveals that global transaction banking has just €27bn in risk weighted assets, compared with €125bn in corporate banking & securities.

“You need some capital for trade finance but for the rest [of transaction banking] it’s pretty much zero,” said Miller. “You have operational risk and you need to set aside some capital for that but you don’t have the counterparty credit risk aspect.”

Banks have increasingly begun to house transaction banking within a broader global markets business, which includes investment banking and trading.

In July last year, US bank JP Morgan said that, since the investment bank, treasury and securities services, and the global corporate bank “currently serve many of the same corporate and investor clients”, they should be “combined into the corporate and investment bank”.

Kevin Brown, global head of transaction services at RBS, said: “Some organisations – particularly those with large investment banking arms – have focused heavily on event-driven activity. Other banks have switched their focus more on the ongoing relationship, ensuring that regular business is there, and have de-emphasised a little the event-driven activity.”

But culture may get in the way of mixing investment banking and transaction banking. Miller said: “In recent years, there has been more interest from capital markets in transaction banking and attempts to integrate the coverage model and product proposition, but what often hinders that is a very different culture and business economics.”

The business is not without its material risks. Part of the transaction banking offering is to lend money. Deutsche Bank lost €170m due to credit loss provisions in 2012 – 4.2% of total transaction banking net revenues. And, for all the talk about the business being capital efficient, different businesses tell different stories.

Berndt said: “Not all GTS businesses are created equal: for example trade finance is more complex, and has greater capital implications, than cash management.

“Each product has different cost dynamics. Across the portfolio of products that comprises GTS, increasing the share of GTS wallet you have with a client generally improves the return of the economic capital of that relationship.”

Key investment

Creating a coherent and efficient infrastructure on which to develop transaction banking is also expensive. Industry insiders estimate infrastructure spending running into the tens of millions a year, just to keep systems running, let alone updating them for the codex of new incoming regulation.

Miller believes there’s no way around it, describing infrastructure investment as “the key” in transaction banking.

Yet efficiencies are available and Berndt believes that “the smart banks are playing the collaboration game as part of their core strategy”.

She points out that a Fortune 500 company could have needs as generic as moving money from London to Hong Kong and as specialised as getting cash to employees on a remote oil field in Nigeria.

“I really believe we’re going to end up with a one-world alliance of banks. However much the international banks spend, they’re never going to be as effective in every market as some of the leading local banks,” she said.

--This article first appeared in the print edition of Financial News dated February 25, 2013